Stocks Turning Around? Maybe, But Be Careful Investing Using Moving Averages
Are stock averages turning around? The Dow closed the week over 13,000 with all the averages reversing the losses they suffered over the last few weeks. So should we commit more money to stocks now?
One way to make this sort of decision is to use "moving averages" as a guide. Go to any chart service and find out whether the Dow or the S&P, for example, are currently above a relevant moving average, or - even better - if they've recently broken above a relevant moving average.
The two most popular moving averages are the 50-day and the 200-day, although you can find proponents of all sorts of moving averages. But the 50 and 200 day will meet most people's needs for an indicator of the direction of the markets. Sort of. Just remember this:
Using moving averages to guide investment decisions makes sense when you use them judiciously. Relying strictly on one or two moving average "formulas" for buying and selling isn't judicious.
One popular method is buying an item when it's above its 200-day moving average and selling the item when the item moves below its 200-day moving average. I remember a conversation with an individual who attended a seminar in Manhattan where a portfolio manager of some repute claimed to use this method religiously. The manager provided data showing how successful he had been doing so. Perhaps he was successful and his data was accurate. However, the fact is that, since April 2010, if you bought the S&P when it crossed over its 200-day moving average, you lost money, even if you included dividends.
No method such as this works perfectly. Further, these methods frequently work for a period of time, then don't work anymore. As John Hussman explains:
Any method that's worked consistently for any period of time, will stop working the minute I decide to use it.
I suppose that's not the most "scientific" or mathematically proven rule out there. But it's helped me avoid making mistakes like this on more than one occasion. In short, it works for me.
One way to make this sort of decision is to use "moving averages" as a guide. Go to any chart service and find out whether the Dow or the S&P, for example, are currently above a relevant moving average, or - even better - if they've recently broken above a relevant moving average.
The two most popular moving averages are the 50-day and the 200-day, although you can find proponents of all sorts of moving averages. But the 50 and 200 day will meet most people's needs for an indicator of the direction of the markets. Sort of. Just remember this:
Using moving averages to guide investment decisions makes sense when you use them judiciously. Relying strictly on one or two moving average "formulas" for buying and selling isn't judicious.
One popular method is buying an item when it's above its 200-day moving average and selling the item when the item moves below its 200-day moving average. I remember a conversation with an individual who attended a seminar in Manhattan where a portfolio manager of some repute claimed to use this method religiously. The manager provided data showing how successful he had been doing so. Perhaps he was successful and his data was accurate. However, the fact is that, since April 2010, if you bought the S&P when it crossed over its 200-day moving average, you lost money, even if you included dividends.
No method such as this works perfectly. Further, these methods frequently work for a period of time, then don't work anymore. As John Hussman explains:
...it's important to consider a broad range of additional factors as well (breadth, leadership, overbought/oversold conditions, yield spreads, divergences, etc). It’s incorrect to believe that simple moving-average crossover methods have been wildly effective over the long-term; particularly since April 2010, which is the last time that our present methods would have indicated a favorable return/risk profile for the S&P 500. Notably, even the popular trend-following strategy of buying the S&P 500 when it is above its 200-day moving-average has had a net loss since April 2010, including dividends, and even ignoring transaction costs. Trading the 50-day moving-average broke even. The luckiest cross-over strategy turned out to be the 17-week moving-average, which would have gained about 14% since April 2010, ignoring transaction costs, but that same strategy would have historically lagged a buy-and-hold approach even before slippage, so there would have been no basis to prefer it in 2010.Here's a good rule to use, one that I employ for my own decision-making:
Any method that's worked consistently for any period of time, will stop working the minute I decide to use it.
I suppose that's not the most "scientific" or mathematically proven rule out there. But it's helped me avoid making mistakes like this on more than one occasion. In short, it works for me.
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